Downgrades: keep a cool head

The effect of recent political events on South African markets may have you thinking that your best bet is to move your investments out of the market and into cash.

Leigh Kohler, the head of research at Glacier by Sanlam, says at times like these, investment platforms and houses are inundated with investors asking about switching their investments into cash.

Cash investments are investments on short-term, variable-rate deposit with reputable banks and are readily available for use. Cash is free of most investment risk, except for the low risk of the bank failing.

Kohler says you need to remember that, while a cash investment may seem like a safe one, after tax it diminishes your purchasing power over time, as the returns are often not inflation-beating.

South African cash investments outperformed local equities and bonds only once in the 15 years between 2001 and 2016, Kohler says.

Over this period, you would have received an average return of 7.96 percent if you were invested only in local cash investments, 10.12 percent if you were invested only in local bonds, and 17.12 percent if you were invested only in South African equities.

If you try to move your investments into cash and back into the market when things are calm, you are essentially making two very difficult market-timing decisions: when to move out of the market and when to move back in, Kohler says.

Research shows the risks of getting that timing wrong; missing just a few of the best days on the market can have a huge effect on your portfolio.

Shawn Phillips, a research analyst at Glacier by Sanlam, says that, generally speaking, cash performs relatively well in periods of rising interest rates, because investments are short term, and during periods of high stock-market turbulence, due to its defensive nature and low correlation with other asset classes.

While no one can be certain what markets will do going forward, or what returns will be like for various asset classes, what you can be certain of is further volatility. The local share market has experienced heightened volatility since 2015, when former finance minister Nhlanhla Nene was fired.

Being invested over time in equities and listed property, and riding through the volatility, are how you earn inflation-beating returns, Kohler says.

To earn higher returns from local equities and bonds, you have to take on extra risk and this means staying invested and believing in your long-term investment strategy, he says.

At times like this people are emotional, but making decisions about your investments on emotion is an investment no-no, he says. Ideally, however, you need to invest in a combination of asset classes in line with your investment needs, investment time horizon and tolerance for investment risk.

Kohler suggests you make use of a professional investment manager who can make informed calls on the prospects for the different asset classes by investing in a suitable multi-asset fund.

And he suggests you diversify your exposure and ensure you have sufficient exposure to offshore assets.

WHAT TO EXPECT FROM YOUR INVESTMENTS

As savers and retirement fund investors, we should be focused on the long-term returns we can earn, rather than the short-term implications of the recent political events and the downgrading of South African bonds will have short-term implications for your investments

Understanding, what the short term implications may be, however, can be reassuring.

Equities

The local share market, as measured by the All Share index, moved mostly higher after a bit of decline late last week, despite the downgrade of South Africa’s bonds by the ratings agencies this week.

However, you should expect some volatility in equities as the political uncertainty prevails.

Lesiba Mothata, chief economist at Investment Solutions, says volatility is likely to increase and the South African Reserve Bank (SARB) will be closely monitoring the developments in the markets to see if the ensuing sell off becomes disorderly and threatens the stability of the financial system.

Should the decline in bank shares, the rise in bond yields and the fall in the rand create instability in markets through intensified capital flight, it would not be surprising to see a response from the SARB that includes hiking interest rates, even when the recent dovish comments were premised on moderating inflation expectations, Mothata says.

Shaun le Roux, a fund manager at PSG Asset Management, says the South African financial markets have been rocked by negative political developments for some time, and you should remember that a lot of the ‘bad’ news was already reflected in share prices.

He says the global economy is supportive of strong returns from many South African assets, should the political situation stabilise. Commodity prices have recovered sharply over the past year and the drought in the north has been broken, he says.

The weak rand has underpinned strong improvements in the trade balance and the tourism sector has been booming. The global economy is also enjoying a period of synchronised growth, an environment that is usually very kind to emerging-market economic growth, he says.

“In times like these, it is especially important that investors focus on their long-term investment objectives and make decisions that boost the probability of achieving those objectives. Most importantly, take care to avoid the common mistake of selling low and buying high,” he says.

Cash

Adrian Goslett, the regional director and chief executive of RE/MAX of Southern Africa says, if there is an upside to the downgrade, it will be for consumers who have cash. If interest rates rise as predicted, your cash investments will earn a higher return, but remember that if inflation also rises, you may not earn a higher real, or after-inflation, return.

Bonds

The rating downgrade by Standard & Poor’s (S&P) has taken the foreign currency component of debt issued (10 percent of the total) to non-investment grade BB+ and local-currency denominated debt (90 percent) has been pushed one notch down to BBB-, which is still investment grade, Mothata says.

The Fitch downgrade late yesterday takes both local and foreign debt to BB+.

Mothata says S&P decision, although a hugely negative outcome for South Africa, does not impact the country’s eligibility in global bond indices as yet.

South Africa is included in a few indices but the most widely-used global bond benchmark is the Citigroup World Government Bond Index which has clearly-stipulated exit requirements for a country. A country will be removed from the index only if three criteria are met, one of which is that country gets downgraded into non-investment grade by both Moody’s and S&P on its long-term domestic credit.

At this stage, South Africa remains safe within global bond benchmarks as the three exit requirements have not yet been triggered, Mothata says.

South Africa may be excluded from the Barclays Global Aggregate Bond Index as a result of the Fitch downgrade, but the country’s weighting in that index is small at 0.025 percent, Mokgatla Madisha, the head of fixed interest at Sanlam Investment Management, says. Despite the fact that South African bonds are still included in leading indices, Madisha says the bond markets have priced in the downgrade with a 0.8 percentage point increase in bond yields over the past week which reduced bond portfolio values by about four percent.

Madisha says the negative outlook that S&P retained on its rating, suggests that they see scope for further action if there are no corrective actions taken. How policymakers respond to the downgrade is going to be crucial, he says. If South Africa is to regain investment grade status, tough decisions are needed. Faster fiscal consolidation is imperative and the Budget needs to be more resilient, which means expenditure must be more aligned with revenue growth.

Sanlam Investment Management (SIM) nevertheless has a high weighting relative to its benchmark in South African long bonds in its flagship multi asset fund, the SIM Balanced Fund.

The real yield on offer remains attractive relative to that of other developed and emerging markets. Madisha says part of the high yield on offer can be ascribed to the political risk South Africa has been facing.